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What is momentum investment? Should you invest in these funds?

by Shatakshi Gupta

These days momentum investing is getting so much endorsement by many financial influencers on social media. But in practise, the concept still has a relatively modest popularity in comparison to India’s entire investing environment. Nevertheless, they are becoming more and more popular, and even AMCs are catching the momentum bug.

Only UTI had a momentum offering up until last year. Now, IDFC, ICICI, Motilal Oswal, and Aditya Birla Sunlife have all developed their own momentum products. All are passive funds, as expected, and are based on the Nifty200 Momentum 30 index.

Fund houses develop programmes for a variety of purposes, such as to raise money or establish a presence in a new market. However, are momentum funds appropriate for the typical retail investor? Let’s find out

What is momentum investing?

Momentum investing adopts a different strategy than the conventional buy-low-sell-high maxim. It is predicated on the idea that equities with momentum will continue to perform strongly in the near future. Therefore, momentum investing seeks to ride the current wave of performing stocks before hopping onto the following one before the current one slows down. This seems promising and, to many, represents the pinnacle of investing.

How efficient is this strategy?

Investors have recently become interested in momentum. More returns than larger indices have been produced by many momentum methods. Additionally, the outperformance has occasionally been substantial. When compared to the Nifty 200 since its inception, the Nifty 200 Momentum 30 Index, upon which all Indian momentum funds are based, has shown superior performance.

Caution is needed:

Please keep in mind that the majority of this information is based on back-tested data before you accept it as the new best course of action. Furthermore, back-testing and reality can differ. Therefore, what we have is more theoretical than practical. The oldest mutual fund in the industry is actually only a year old. And before placing a large wager on this or any other method, keep that in mind.

Some math implies that momentum techniques should not have rebalancing frequency longer than six months. The frequency should be either weekly or monthly. But to be fair, that would significantly raise the costs and might not be practical.

Given that the index typically consists of a mix of large and mid cap stocks that are traded twice a year, it is fair to argue that the momentum index frequently produces a quite different portfolio than the usual Nifty 50, Next 50, or Nifty 200 indices.

Who should invest in momentum funds?

Read more: Mutual Funds giving negative returns? How can you tap profit from this?

To an investor’s current portfolio of common index funds, large-cap funds, flexi-cap funds, etc., this could offer some tactical diversity. Additionally, due to its structural makeup and periodic rebalancing, this fund may exhibit high short-term volatility. It is therefore best for those who are willing to accept considerable downside volatility. It is also better suited to people with a five-year or longer time horizon.

This shouldn’t take the place of your whole allocation to large-cap stocks. Try not to use these new momentum funds to replace your active large-cap funds, index funds, or flexi-cap funds. It may, at most, be combined with other conventional categories.

What to keep in mind before investing?

Here are a few things to consider.

  • Riding the wave of increasing profits is an intriguing concept, but these funds are still relatively new and untested.
  • If you are a cautious saver with little stock exposure or are new to equity, pass on this category. Limit your investments to flexi-cap, index, and large-cap funds. 
  • You can combine momentum funds with other asset classes like active or passive large-cap funds, flexi-caps, mid-caps, etc. if you have a moderate appetite for volatility and consider yourself an aggressive investor. You’ll be able to diversify your style and approach as a result.

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